Canto 14

Growth and Value: How Important is Investment Style?

Two popular "styles" of investing are growth and value. Within a given country's market, and within an overall size category (such as large capitalization companies), you can select stocks that that are either value-oriented or growth-oriented or on the continuum somewhere in between. What do these things mean and how important are they?

Growth Investing

Growth investors primarily invest in growth stocks, which are shares of companies that are expected to grow faster than the average for the stock market as a whole. They tend to be in industries like high tech, where the companies are trying to expand rapidly and therefore invest most of their profits back into the firm.That means they don't tend to distribute dividends to the shareholders. A company in the growth category will typically have a high P/E ratio. You can invest in growth stocks either by buying them directly through a broker or by finding a growth-oriented mutual fund or ETF.

Growth stocks tend to grow more than the market average during market upswings. Particularly towards the end of a bull market, when the market has been rising for a while, growth stocks develop a sort of momentum as investors jump on the bandwagon and buy these exciting rising stocks. On the other hand, in bear markets, growth stocks often fall faster than the rest of the market.

Value Investing

Value investors primarily invest in value stocks, which are shares of companies that are selling at a low price relative to their earnings or other ways to measure the value of the a company. In other words, investors buy these stocks because they think they are on sale. They tend to be in well-established industries, like food or appliances, and they are usually not trying to expand rapidly so they are able to distribute some of their profits to the investors. That means they tend to have high dividend yields and low P/E ratios. You can invest in value stocks either by buying them directly through a broker or by finding a value-oriented mutual fund or ETF.

Value stocks tend to lag growth stocks during market upswings, but they don't fall as much in down markets. Their total returns include dividends as well as the change in stock price with time. Many investors find the relative certainty of getting a dividend each year reassuring, because dividends are fairly reliable. Many companies have been distributing dividends every year for decades, even in years when their stock price goes down a bit.

How Do They Compare?

An analysis of year-by-year results for US stock mutual funds (using data from Morningstar.com for the years 2002-2011) compared growth mutual funds, value mutual funds, and index mutual funds in three different size categories. The results were not the same in all three size categories, but using large stock funds as an example, growth funds had the largest returns in four of the years, value funds had the largest returns in three of the years, and index funds had the largest returns in three of the years. The 10-year annualized returns for the three categories were: 4.12% for index, 4.09% for value, and 4.04% for growth. This is a statistical tie. The spreads were a bit wider in the other two size categories. For mid-capitalization stock funds, index funds came out ahead by a margin of about 2%, and for small capitalization stock funds, value funds came out ahead by a bit over 1%.

If you picked a different time period, you would get different results. For example, if you picked a period when the market was generally rising, growth funds would tend to win. If you picked a period when it was generally falling, value funds would tend to win. Unfortunately, this only works for the past since you never know what kind of period you are heading into.

I think in general that people with an aggressive attitude to investing and a long investment horizon would tolerate the volatility of growth funds better than people who are more conservative or who are investing for a goal that is closer in time. For people who want to diversify between the two approaches, index funds are a good choice, partly because on average they tend to have lower fees.

How Important is Style?

I think investment style should be fairly low down on your list of things to consider when picking funds. The following choices all seem more important to me:

Finally, given the modest difference between the three styles among large US stock funds, I think the difference between styles is much less important than the fees you might pay if you are investing in mutual funds and ETFs. (If you are buying stocks directly, this is less of an issue.) The difference in annual returns between large cap index funds and large cap growth funds was only 0.08% per year. The difference between what an average Canadian mutual fund charges in fees and what an average Canadian ETF charges in fees is 1.7% per year. That's over 20 times as large a difference. You can't predict what type of market we will have for the next ten years, but you can expect funds to continue charging roughly the same fees from year to year. Therefore, whether you pick growth or value or index styles, or some combination, make sure you pay attention to costs.


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Last Updated: 14 July 2015
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